Official translation 29 December Lithuanian Draft Budgetary Plan

Transcription

1 Official translation 29 December Lithuanian Draft Budgetary Plan 15 December 2016

2 TABLE OF CONTENTS Introduction The macroeconomic situation and prospects Fiscal policy General government financial indicators under the policy change scenario Description of the structural labour market and social reform the social model Tax administration measures in Links between the DBP and the Council of Europe Recommendations, as well as the DBP and the Objectives set by the European Union s Strategy for Growth and Jobs Methodological aspects Tables Table 1 (0.i). Key assumptions... 6 Table 2 (1a). Macroeconomic indicators... 6 Table 3 (1b). Price developments... 7 Table 4 (1c). Labour market developments... 7 Table 5 (1d). Sector balances... 8 Table 6. Economic and finance impact of the social model Table 7. Impact of the social model on general government finances in Table 8 (2a). General government financial targets broken down by subsectors Table 9 (2b). General government debt development Table 10 (2c). Contingent liabilities Table 11 (3). General government revenue and expenditure indicators broken down by main budget headings in case of no-policy change scenario Table 13 (4b). Amounts to be excluded from the expenditure benchmark Table 15 (5a.ii). Discretionary expenditure measures taken by general government Table 19 (8). Preparation of economic development scenario

3 Introduction Lithuania, following the general provisions of Regulation (EU) No 473/2013 of the European Parliament and of the Council of 21 May 2013 on common provisions for monitoring and assessing draft budgetary plans and ensuring the correction of excessive deficit of the Member States in the euro area (hereinafter the Regulation), provides the European Commission and the Euro Group with the updated Lithuanian 2017 Draft Budgetary Plan (hereinafter the DBP), which includes the policy measures approved by the new Government 1. This DBP was developed in accordance with the Economic Development Scenario prepared by the Ministry of Finance and approved by the Independent Budget Control Institution 2, having assessed the legal acts regulating social field and labour market approved in the middle of 2016 and with effect from 1 January 2017 and 1 July 2017, which jointly implement the structural reform of social and labour market referred to as the social model. In this DBP Lithuania provides detailed information on the social model and addresses the European Commission with a request to evaluate the compliance of the structural reform social model with the provisions of the Stability and Growth Pact, foreseeing a possibility for the Member States implementing a major structural reform oriented towards improvement of long-term financial sustainability and a higher potential of economic growth to make use of flexibility of the Stability and Growth Pact. This DBP also elaborates on comprehensive information on the better tax administration measures to be applied in Within updated DBP, having regard to the observations by the European Commission, other institutions and the new discretionary measures for 2017, the nominal and structural deficits of the general government are projected to be lower by 0.1% of GDP, as compared to the primary DBP, which was submitted to the Parliament on 17 October In addition, we provide the information on the DBP 3 approval schedule following national legislation: First hearing of the DBP at the Seimas of the Republic of Lithuania (hereinafter the Parliament) took place on 24 November After the hearing, the Parliament returned (in accordance with the usual procedures) the DBP to the Government for reconsideration and adjustment having regard to the proposals by the Members of the Parliament; After the elections of the Parliament, on the recommendation of the President and by the decision of the Parliament the new Prime Minister was appointed on 22 November Following Article 92 of the Constitution of the Republic of Lithuania, no later than within 15 days after the appointment, the Prime Minister presents to the Seimas the Government formed and approved by the President and submits the Government Programme for consideration. On 13 December 2016 the Parliament approved the Programme of the Seventeenth Government, and the new Government was granted authorisations; 1 Due to the elections of the Seimas of Republic of Lithuania that took place in October 2016, after which the new Government is approved, on 17 October 2016 the European Commission and the Euro Group were provided with the DBP based only on the no-policy change scenario (i.e. in accordance with the commitments assumed just by 17 October 2016) DBP within this paragraph refers to the totality of the Draft Law on the Approval of Financial Indicators of the State Budget and Municipal Budgets for the year 2017, the Draft Law of the State Social Insurance Fund budget of the year 2017, the Draft Law on the Compulsory Health Insurance fund budget of the year

4 On 14 December 2016 the Government approved the updated DBP and submitted it to the Seimas for the second hearing. Following Article 177(2) of the Statute of the Seimas of the Republic of Lithuania (hereinafter the Statute), in the election year the second hearing of the DBP takes place no later than on 18 December. Following Article 177(5) of the Statute, the Parliament, after discussions, votes on the approval of the DBP in one of the coming sittings of the Parliament. Following Article 131 of the Constitution, the DBP is approved by the beginning of the new budgetary year. It is planned that final decision of the Parliament on the approval of the DBP will be adopted on 20 December In view of the current situation, following national legislation, de jure situation, when there is no possibility to submit the updated DBP to the European Commission and the Euro Group 30 days in advance to the approval of the DBP at the Parliament, has formed. Lithuania took all the possible measures so that after granting the authorisations to the Government the DBP is submitted as soon as possible, and it was done within 2 days. De jure there exists a possibility to adjust the budget in The macroeconomic situation and prospects The DBP presents the Lithuanian economic development scenario for , developed by the Ministry of Finance and approved by the Budgetary Policy Monitoring Authority, which was posted on the website of the Ministry of Finance at on 12 September The economic development scenario was developed on the basis of data collected before 30 August The conclusion of the Budgetary Policy Monitoring Authority on the economic development scenario was posted online at The assumptions of the external economic environment (oil prices, the euro-to-dollar exchange rate and the prospects of the EU and euro area economies) match the forecasts made in the European Commission's July 2016 survey The Economic Outlook after the UK Referendum: a First Assessment for the Euro Area and EU. As Article 50 of the Lisbon Treaty has not been invoked yet, the process of United Kingdom's separation has not begun. According to the information available at the time of the preparation of the economic development scenario, an assumption was made that negotiations on the United Kingdom's exit from the European Union ( EU ) would not begin before the end of Upon invocation of Article 50 of the Lisbon Treaty, the process of negotiations on the separation takes up to 2 years, although the European Council may extend the negotiation time limit, with the Member States' consent (the assumption was that the negotiations may last more than 2 years). Bearing in mind that during the negotiations all the mutual commitments between the United Kingdom and the European Union remain valid, we assume that there will be no essential changes (such as a change in the trade regime or immigration policy) before It is estimated that the growth of Lithuania s gross domestic product ( GDP ) will be at 2.3 per cent in Subsequently, it will grow slightly faster, by 2.7 per cent in 2017 and by 2.5 per cent in both 2018 and Despite the moderate GDP growth, Lithuania's GDP will grow faster than that of the EU and the euro area, while the situation of residents in the period covered by the economic development scenario will continue to improve: unemployment rate will decline and the purchasing power of residents will retain its strength, as wages will grow faster than inflation. 4

5 In 2016, the average gross wage in the country is expected to grow by 7.4 per cent. In , changes in the average gross monthly wage will depend on the development of the economic factors, namely labour supply and demand, labour productivity, inflation and business profitability. The average gross monthly wage in the country should rise by 6.2 per cent in 2017, 6.1 per cent in 2018 and 6.3 per cent in The good financial situation enjoyed by the residents will ensure a rather rapid growth in household consumption expenditure at current prices in the medium term, at an average of 6.4 per cent per year (real growth in this expenditure will total around 4.4 per cent per year). Investment development in early 2016 was suppressed by the change of the EU financial periods, i.e. by a decrease in the EU structural funds resources resulting from the overlap between the and financial periods. In 2015, investments came from both financial periods, but in 2016 only funds from the new period were invested. The volumes of projects implemented using EU funds resources have grown from the second half of 2016, yet the poor performance in the first half of 2016 (a decline of 1.2 per cent) is likely to result in a negative change (-2.6 per cent) in gross fix capital formation. With the accelerated implementation of projects financed from the EU funds resources as of 2017, gross fixed capital formation will also grow: by 6.3 per cent in 2017, 6.5 per cent in 2018 and 6.7 per cent in The share of gross fixed capital formation in the GDP is likely to increase to 22.1 per cent in 2019, exceeding the multi-annual average of the indicator (21.1 per cent). Employees enjoy a favourable market situation, stimulating a rapid growth in wages and influencing price changes, especially in the service sector. Labour costs have been rising fuelled by the minimum monthly wage raise, resulting in higher prices of the services provided by the service sector employees. Over the last 1.5 years, the growth of service prices has remained stable, averaging 3.4 per cent per year. Given the anticipated stable pace of growth in wages, the service price growth trends are not likely to change significantly in the medium term. Core inflation (measured on the basis of the Harmonised Index of Consumer Prices (hereinafter referred to as HICP), excluding energy products and unprocessed food) has remained stable over the last two years and averaged 1.2 per cent in Surging real wages and household consumption expenditure in the first half of 2016 raised the annual core inflation level to 2 per cent. As wages grow faster than labour productivity in the medium term and the domestic demand rises as well, the core inflation rate will gradually gain speed and approach the multi-annual average (2.4 per cent). The average annual inflation, estimated based on the HICP, is expected to amount to 0.7 per cent in 2016, 2.2 per cent in 2017, 2.5 per cent in 2018 and 2.5 per cent in The external environment resulting from the Brexit-induced economic uncertainty will remain unfavourable to Lithuanian exporters. They will have to adapt to the new economic realities, to increase investment in competitiveness and currency risk management and to adopt decisions reducing the production costs and increasing operational efficiency and production volumes. Guarded optimism on the prospects of export stems from the reorientation of the Lithuanian export markets in 2015, which has created an opportunity to gain ground and to expand exports in the already discovered third countries, in particular the ones paying in dollars. The results of the year 2015 show that Lithuanian companies are capable of adapting and increasing the volumes of exported products even in unfavourable conditions. The export value of products of Lithuanian origin (aside from mineral products affected by the drop in oil prices) rose by 3.2 per cent in The pace of growth primarily owes to the growing exports of vegetable products, furniture, machinery and mechanical appliances and products of the chemical industry of Lithuanian origin. 5

6 In the light of the Brexit-induced changes in the external environment, we predict a 4.9 percent real growth in the export of goods and services for 2016, 2.8 per cent for 2017, 3.1 per cent for 2018 and 3.3 per cent for Table 1 (0.i). Key assumptions Short-term interest rate (annual average) Long-term interest rate (annual average) USD/EUR exchange rate (annual average) Nominal effective exchange rate World GDP growth (excl. EU), % EU GDP growth, % Growth of relevant foreign markets, % World import volumes (excl. EU), % Oil prices (Brent, USD/barrel) Sources: European Commission, Ministry of Finance Table 2 (1a). Macroeconomic indicators ESA EUR code Change, % million 1. Real GDP, chain-linked volume B1*g * 1.8* Potential GDP of which: - labour capital total factor productivity Nominal GDP B1*g * 2.0* GDP components (at constant prices) 4. Household consumption expenditure + NPI serving P * 4.1* households 5. Government consumption expenditure P * 0.9* Gross fixed capital formation P * 4.7* Changes in inventories and net acquisition of valuables (% of GDP) P.52 + P.53 N.A. N.A. N.A. N.A. 8. Exports of goods and services P * -0.4* Imports of goods and services P * 6.2* Contributions to GDP growth at constant prices 10. Final domestic demand - 6.6* Changes in inventories and net P.52 + acquisition of valuables P.53 N.A. N.A. N.A. N.A. 12. External balance of goods and services B * * On 30 September 2016, Statistics Lithuania recalculated the 2015 data, yet the economic development scenario was developed using the data collected prior to 30 August 2016 Sources: Statistics Lithuania, Ministry of Finance 6

7 Table 3 (1b). Price developments ESA code Level Change, % 1. GDP deflator 110.9* 0.2* Private consumption deflator 107.6* -0.9* HICP (year 2015 = 100) Government consumption deflator 114.7* 5.0* Investment deflator 109.7* 1.5* Export price deflator (goods and services) 106.2* -4.0* Import price deflator (goods and services) 103.9* -6.9* * On 30 September 2016, Statistics Lithuania recalculated the 2015 data, yet the economic development scenario was developed using the data collected prior to 30 August Sources: Eurostat, Statistics Lithuania, Ministry of Finance Table 4 (1c). Labour market developments ESA code Indicator value Change, % 1. Employment, persons ( 000) Employment, hours worked Unemployment rate (%) Labour productivity (real gross value added per employed 25.2** 0.4** person), 000 EUR 5. Labour productivity, hours worked 13.5** -1.5** Compensations of employees, million EUR D * Compensation per employee, EUR * *Value of the indicator ** On 10 October 2016, Statistics Lithuania recalculated the 2015 data, yet the economic development scenario was developed using the data collected prior to 30 August 2016 Sources: Statistics Lithuania, Ministry of Finance 7

8 Table 5 (1d). Sector balances ESA code % of GDP 1. Net lending/borrowing vis-à-vis the rest of the world B of which: - balance on goods and services -0.7* balance of primary incomes and transfers capital account Net lending/net borrowing of the private sector B Net lending/net borrowing of general government B Statistical discrepancy * On 30 September 2016, Statistics Lithuania recalculated the 2015 data, yet the economic development scenario was developed using the data collected prior to 30 August 2016 Sources: Bank of Lithuania, Ministry of Finance 2. Fiscal policy 2.1. General government financial indicators under the policy change scenario The general government deficit projected for 2016 will be 0.6 per cent of GDP, which is lower than the 1.2 per cent deficit target approved by the Seimas and the projection of -0.8 per cent of GDP presented in the Stability Programme for Lithuania for 2016, approved by Resolution No 417 of the Government of the Republic of Lithuania of 27 April A better result is expected due to overperformance of the State budget and Social Insurance Funds Budgets revenue plans and a better than projected local government subsector performance. The medium-term objective set out by the Seimas is 1 per cent of GDP structural general government deficit. In 2014, Lithuania reached the medium-term objective. In 2015, when government deficit fell to its lowest levels since the restoration of independence (0.2 per cent of GDP), there was no deviation from the medium-term objective, i.e. the structural general government balance improved to -0.5 per cent of GDP. Despite the risks to Lithuania's economy from external economic factors and the unfavourable internal demographic processes, the economy's capacity to deal with the challenges posed by external environment, adherence to fiscal rules and application of measures for improving revenue administration will put in place conditions that will not allow the structural general government balance to deviate from the medium-term objective in The structural general government deficit in 2016 will be about 0.9 per cent of GDP. The structural labour market and social protection reform (social model) that is to be launched in 2017, coupled with the tax measures aimed at increasing the income from labour relations of the country s population with the lowest earnings, will have, in the short-term period, a negative impact on the general government balance, which as a result will be in deficit in 2017, while, if excluding the impact of the said measures, the general government sector in 2017 would be in surplus. In 2017, the general government balance is projected to be 0.7 per cent of GDP deficit at current prices (structural general government deficit will be at 1.2 per cent of GDP). From 1 January 2017 and 1 July 2017, the social model that has been approved de jure is to be launched, which will cost 0.5 per cent of GDP in

9 The 2017 budgetary plan provides for other key (other than social model-related) measures: the increases of the amount of non-taxable income and the additional amount of non-taxable income will cost EUR 144 million, an additional amount of EUR 41 million will be earmarked for pay rises of educators, the salary increases of cultural and artistic workers will cost EUR 7.1 million and the implementation of the law on payment for work of the employees of state and municipal institutions and the pay rises of statutory officers is estimated at EUR 39.2 million. These costs will be partially offset by the incease of the excise rates on tobacco products with an anticipated EUR 26 million in additional revenues and a faster increase of excise rate on alcoholic beverages which will bring in additional revenues EUR 45 million. The VAT exemption on medicines and medical aid devices contained in outer packaging which taxable amount exceeds EUR 300 will result in EUR 12 million loss in budget revenues. The general government finance indicators take into account the already approved measures aimed at a better tax revenue administration, applicable from the fourth quarter of 2016 and starting Description of the structural labour market and social reform the social model Scope and objectives of the social model The reform, i.e. the social model is focused on more flexible labour relations, higher employment, more sustainable social insurance and reduction of poverty. The purpose of the new social model is to ensure the necessary guarantees as well as a better match between work and family commitments for employees, while for employers it offers creating a more favourable environment for the recruitment and retention of workforce. The increased flexibility of labour relations aims to attract more investment, create additional workplaces and provide conditions for ensuring financial sustainability of the pension system as well as adequacy of pension benefits. The relationship of the social model with country-specific recommendations of the Council of Europe for Lithuania The reform, i.e. the social model implements the European Council s Recommendation 2015 for Lithuania: Adopt a comprehensive reform of the pension system that also addresses the challenge of achieving pension adequacy. Improve the coverage and adequacy of unemployment benefits and cash social assistance and improve the employability of those looking for work and the part of the European Council s Recommendation 2016 for Lithuania to improve the coverage and adequacy of unemployment benefits and social assistance. Drafters and independent assessors of the social model In the framework of the Human Resources Development Operational Programme for , Priority 4 Strengthening of Administrative Capacities and Increasing Efficiency of Public Administration, implementation measure VP1-4.3-VRM-02-V Promotion of Public Policy Reforms, Vilnius university, in co-operation with partners from the Social Research Centre, Mykolas Romeris University and other independent experts, drafted a new legal-administrative model of the Lithuanian labour relations and state social insurance, proposing a comprehensive structural labour market and social reforms. A detailed description of the new social model, information about the drafters, related research, cost and benefit analysis as well as other information is provided on a special website at: 9

10 Legal status and main legislation of the social model The social model law package comprises the following most relevant laws: the Labour Code of the Republic of Lithuania (hereinafter the Labour Code ), the Republic of Lithuania Law on Employment, the Law Amending the Law of the Republic of Lithuania on State Social Insurance No I-1336, the Republic of Lithuania Law Amending Law on State Social Insurance Pensions No I- 549 and the Republic of Lithuania Law Amending Law on Unemployment Social Insurance No IX Main legal acts constituting the social model 1. Law of the Republic of Lithuania on the Approval, Entry into Force and Implementation of the Labour Code (new version) (No XIIP-3234(3)) 2. Law Amending Article 19 of the Law on Bankruptcy of Enterprises No IX (No XIIP-3244(2)) 3. Law Amending Article 4 of the Law on Guarantee Fund No VIII (No XIIP-3245(3)) 4. Law Amending Article 10 of the Law on State and Municipal Enterprises No I-722 (No XIIP-3247(2)) 5. Law Amending Articles 19 and 70 of the Law on the Diplomatic Service No VIII-1012 (No XIIP-3248(2)) 6. Law Amending Article 14 of the Law on Social Enterprises No IX-2251 (No XIIP-3249(2)) 7. Law Amending Article 15(1) of the Law on Health Care Institutions No I-1367 (No XIIP-3250(2)) 8. The Law Amending Articles 1, 6, 8, 9, Section Four (1) and the Annex and Repealing Article 13(1) of the Law on the State Labour Inspectorate No IX-1768 (No XIIP-3264(2)) 9. Law on Employment(No XIIP-3240(2)) 10. Law Amending the Law on Unemployment Social Insurance No IX-1904 (new version) (No XIIP-3237(3)) 11. Law Amending the Law on Social Insurance of Occupational Accidents and Occupational Diseases No VIII-1509 (new version) (No XIIP-3238(2)) 12. Law on the Guarantees to Employers in the Event of Employer s Insolvency and Long-Term Employment Benefits (No XIIP-4524(3)) 13. Law Amending the Law on State Social Insurance No I-1336 (new version) (No XIIP-3235(3)) 14. Law Amending Articles 2, 4, 5, 6, 11 and 14 of the Law on the Structure of the Budget of the State Social Insurance Fund No IX-547 (No XIIP-3251(2)) 15. Law Amending Articles 1, 3, 12, 13 and Title of Section Four of the Law on Benefits for Children No I-621 and Supplementing thereof with Articles 10(1) and 10(2) (No XIIP-3267(2)) 16. Law Amending Articles 50 and 57 of the Law on the Statute of Internal Service No VIII-1012 (No XIIP-3258(2)) 17. Law Amending Articles 65, 66, 67, 68, 70 and 72 of the Law on the Organization of the National Defence System and Military Service No VIII-723 (No XIIP-3260(2)) 18. Law Amending the Law on Sickness and Maternity Social Insurance No IX-110 (new version) (No XIIP-3236(3)) 19. Law Amending Articles 17 and 38 of the Law on Personal Income Tax No IX (No XIIP-3254(2)) 20. Law Amending Articles 1, 2, 3, 9, 10, 12, 13, 16, 21, 22, 25, 26, 27, 29, 31, 33, 34, 35, 44, Section V and the Annex of the Law on Safety and Health at Work No IX and Supplementing thereof with Section V(1) (No XIIP-3243(3)) 21. Law Amending the Law on State Social Insurance Pensions No I-549 (new version) (No XIIP-3239(3)) 22. Law Amending Articles 3,4,5 and 6 of the Law on Reform of the Pension System No IX-1215 (No XIIP-3252(2)) 23. Law Amending Articles 3, 4, 5, 9, 10, 14, 15 and 16 of the Law on State Pensions No I-730 (No XIIP-3255(2)) 24. Law Repealing the Law on Advance Payment of State Social Insurance Old-Age Pensions No IX-1828 (No XIIP-3262(2)) 25. Law Amending Article 2 of the Law on Establishment of Reference Values and Basic Rate of Fines and Penalties of Social Security Benefits No X-1710 (No XIIP- 3263(2)) 26. Law Amending Article 3 of the Provisional Law on the State Pensions of Scientists No I-732 (No XIIP-3257(2)) 27. Law Amending Articles 3, 4, 10, 17, 23, 25, 15 and 27 of the Law on Accumulation of Pensions No IX-1691 (No XIIP-3261(2)) 28. Law Amending the Law on State Social Assistance Benefits No I-675 (new version) (No XIIP-3265(2)) 29. Law on Target Compensations (No XIIP-3266(2)) 30. Law Amending Articles 737, 738 and 739 of the Code of Civil Procedure (No XIIP-3242(2)) 31. Law Amending Articles 8, 10 and 17 of the Law on Monetary Social Assistance for Low Income Residents No IX-1675 (No XIIP-3246(2)) 32. Law Amending Articles 29 and 30 of the Law on Social Services No X-493 (No XIIP-3253(2)) Measures of the social model and the implemented substantial changes The new Labour Code aims to eliminate the deficiencies of regulation of employment relations, reduce undeclared employment and encourage different labour contract forms, balance employment guarantees and combine flexibility with employment security. The provisions of the new Labour Code will make it easier for employees to combine work with other responsibilities either towards family or science, while encouraging employers to create legal jobs and not rush with employee dismissal at the onset of crisis. The following novelties of the Labour Code may be distinguished: 1) New types of employment contracts (project-based employment contract, job sharing employment contract, employee sharing contract, apprenticeship employment contract). Introduction of new types of employment contracts will allow employers to choose a more 10

11 acceptable method of formalization of labour relations and will encourage them to define working relations in the areas, where at present they are not formalized or where civil relations are defined. 2) Shorter periods of notice and lower severance allowances for dismissed employees. Currently, long notice periods and large severance allowances (up to 6 monthly average wages) discourage the employers from creating new jobs, as they fear that in case of a business failure, they will not be able to pay large severance allowances. 3) More flexible regulation of the working hours (abandonment of strict regulation of working day hours, greater annual limit for overtime work, and easier introduction of cumulative recording of working time) will encourage employers to create new jobs more easily. 4) Reduction of administrative burden (e.g. an obligation to record in timesheets the deviations from the standard working hours is imposed only in relation to the employees who work under cumulative working time recording and those who work at night). The reduction of administrative burden will enable the creation of jobs that generate a higher added value. The Law of the Republic of Lithuania on Employment expands the scope of application of the current support of employment by providing a classification of forms of employment; legalizes a new more efficient model of application of active labour market policy measures, which could help address employment challenges of persons on social assistance and reduce long-term unemployment risk; provides extensive opportunities for the unemployed for learning and on-the job practice in order to achieve maximum efficiency in the integration of the unemployed into the labour market; reduces the risk of illegal employment, i.e. provides for a liability for illegal and undeclared work or undeclared independent activity as well as violations of the procedure for the employment of foreigners; encourages a more sustainable creation of jobs, alignment with workforce demand, more flexible labour relations and social security tailored to the population needs. The Law Amending the Law of the Republic of Lithuania on Unemployment Social Insurance No IX-1904 provides for an increase in the number of the insured persons who are entitled to the unemployment social insurance benefit; ensures adequate unemployment social insurance benefits, while taking into account the change of the status of an unemployed person; specifies the grounds for suspension and termination of benefit payments. The above-mentioned laws also provide for a reduction of the pension social insurance contribution rate to be paid by employers and financing of the basic pension with the State budget resources. This would be implemented gradually and in compliance with fiscal discipline. The Law Amending the Law of the Republic of Lithuania on State Social Insurance Pensions No I-549 proposes a reform of the system of state social insurance pensions, i.e. moving towards a clearer and more transparent calculation of pensions, while making pension levels more dependable on pension insurance contributions and creation of conditions for ensuring the financial sustainability of the pension system as well as adequacy of pension benefits. The Law provides for: 1) considering the component of the pension that depends on the state social insurance contributions as an individual pension component (it is proposed to introduce a system of units of account) and to finance it from the State Social Insurance Budget, while considering the pension component that depends on the length of service, but is not directly related to the size of contributions paid, as the general pension component and gradually transfer its payment to the State budget; 2) establishing a pension indexation procedure based on clear criteria that allow the assessment of both the economic conditions and demographic indicators (pensions would be indexed according to the average change of the wages fund for 3 past years, current year and 3 forecast years); 11

12 3) a gradual increase of the required length of pensionable service from 30 to 35 years; 4) a change of the procedure for calculation of lost working capacity pensions, i.e. relating the sizes of lost working capacity pensions to the level of capacity for work in per cent estimated for a person. Expected positive impact of implementation of the social model on economic growth potential, assessment method and assumptions Implementation of these legislative acts will allow for improving labour market operation, making the labour market more dynamic and labour relations more flexible; workers will be offered guarantees of staying in the labour market, the coverage and adequacy of the unemployment social insurance benefits will improve. As a result of the reform the average annual number of the employed in the medium term will increase up to 10%, while the average annual number of the employees working standard annual hours up to 7%. Employment growth has been calculated after conducting a survey of employers designed to find out what provisions would encourage them to create new jobs. Factors contributing to the increase in employment: 1. Provisions of the Labour Code that will enable employers to create new jobs. 2. Othre provisions are: 1) the change in the unemployment social insurance benefit conditions and an increase in contribution rates for this type of insurance will ensure qualitative protection for persons who lost their jobs as a result of more flexible employment conditions; 2) widening of the social insurance contributions base for persons engaged in individual activities will ensure higher quality of social security for these persons. 3) the reduction of the social insurance contribution rate to be paid by employers. Expected positive impact of implementation of the social model on the sustainability of general government finances, assessment method and assumptions In order to make a comprehensive long-term assessment of the impact of the proposals for the pension system reform on the budget of the State Social Insurance Fund, in 2016, a cost assessment of the pension system reform was performed in accordance with the Law Amending Law of the Republic of Lithuania on State Social Insurance Pensions No I-549 by using the cohort pension system model LSIM [Lithuanian Social Insurance Model]. The pension expenditure projection provided in the Stability Programme for 2016 was used for the baseline option in accordance with the then existing laws and macroeconomic assumptions. In calculating the impact of the reform, only the pension reform measures were taken into account without changing the conditions, i.e. the indexation rate was changed by introducing the 7-year average wage fund index instead of the wage growth index and a new rule of the required period of pensionable service was applied to new retired persons. The assessment of the impact took into account the economic and employment assumptions for agreed by the Economic Policy Committee (EPC) in autumn Given that the adopted pension indexation allows for estimation of the worsening ratio between contribution payers and beneficiaries and that the increase in the required period of pensionable service allows for non-assuming of greater obligations in terms of higher life expectancy, in future the proposals for the pension reform in the longer term would enable annual average pension expenditure savings of 3.7% of GDP as compared to the scenario, provided no changes are made. 12

13 Table 6. Economic and finance impact of the social model Description of the reform (1) I. The purpose of the reform is to attract investment to Lithuania s economy and create new jobs. To implement this purpose, a new Labour Code has been developed and approved by the Seimas (hereinafter the Labour Code ). Along with the new Labour Code, the Law Amending the Law on Unemployment Social Insurance, Law Amending the Law on Social Insurance of Occupational Accidents and Occupational Diseases, Law Amending the Law on State Social Insurance and the Law Amending the Law on Sickness and Maternity Social Insurance were adopted. Main characteristics of the model used/calculation method (2) Employment growth has been calculated following a survey of employers designed to find out what provisions of the draft Labour Code and what other provisions would encourage employers to create new jobs. Methodological elements Quantitative elements Anticipated implementation Main macroeconomic assumptions/modelling assumptions (3) The provisions of the Labour Code that will enable employers to create new jobs: 1) New types of employment contracts (project-based employment contract, job sharing employment contract, employee sharing contract, apprenticeship employment contract). Introduction of new types of employment contracts will allow employers to choose a more acceptable method of formalization of labour relations and will encourage them to define working relations in the areas, where at present they are not formalized or where civil relations are defined. 2) Shorter periods of notice and lower severance allowances for dismissed employees; currently, long notice periods and large severance allowances (up to 6 monthly average wages) discourage the employers from creating new jobs, as they fear that in case of a business failure, they will not be able to pay large severance allowances. 3) More flexible regulation of the workinghours (abandonment of strict regulation of working day hours, greater annual limit for overtime work, easier introduction of cumulative recording of working time) will encourage employers to create new jobs more easily. 4) Reduction of administrative burden (e.g. an obligation to record in timesheets the deviations from the standard working hours is imposed only in relation to employees who work under cumulative working time recording and those who work at night). The reduction of administrative burden will enable the creation of jobs that generate a higher added value. Description (5) Employment Main outcome of macroeconomic modelling (4) Annual and general impact on GDP and other key macroeconomic variables(6) Year x +5 As a result of the reform the average annual number of the employed in the medium term will increase up to 10%, while the average number of employees working standard annual hours up to 7%. Year x +10 Year x +15 Year x +20 Year X+25* Other impacts/ indicators (7) Deadline for approval and implementation of measures (8) Legal acts will enter into force on 1 July 2017 Institutional process of adoption of measures (9) Laws are adopted.

14 Reform of social insurance pensions: indexation of pensions linked to the growth rates of the wages fund (according to the average change of the wages fund for 3 past years, current year and 3 forecast years) and increase of the required length of pensionable service from 30 to 35 years by half a year annually from 2018 to In order to make a comprehensive long-term assessment of the impact of the proposals for the pension system reform on the budget of the State Social Insurance Fund, the cost assessment of the pension system reform was performed in accordance with the Law Amending the Law of the Republic of Lithuania on State Social Insurance Pensions No I- 549 by using the cohort pension system model LSIM [Lithuanian Social Insurance Model]. Other provisions are: 1) the change in the unemployment social insurance benefit conditions and an increase in contribution rates for this type of insurance will ensure high-quality protection for persons who lost their jobs as a result of more flexible employment conditions; 2) widening of the social insurance contributions base for persons engaged in individual activities will ensure higher quality of social security for these persons. 3) the reduction of the social insurance contribution rate to be paid by employers. The pension expenditure projection provided in the Stability Programme for 2016 was used for the baseline option in accordance with the then existing laws and macroeconomic assumptions. In calculating the impact of the reform, only the pension reform measures were taken into account without changing the conditions, i.e. the indexation rate was changed by introducing the 7-year average wage fund index instead of the wage growth index and a new rule of the required period of pensionable service was applied to new retired persons. The assessment of the impact took into account the economic and employment assumptions for agreed by the Economic Policy Committee (EPC) in autumn Direct fiscal impact on primary balance, % BVP (improvement) Otherwise: Annual impact on pension balance (reduction in pension expenditure), % BVP -0.8% -2.1% -3.1% -3.7% -3.8% Indexation of pensions will start from 2017, while the required length of pensionable service will be gradually increased from 30 to 35 years by half a year annually from 2018 to Laws are adopted. With a view to assessing the impact of the model, two scenarios have been defined which were compared with each other in order to evaluate the impact of the model being designed on Lithuania s social insurance system, i.e. the budget of the State Social Insurance Fund and the labour market. Source: Ministry of Social Security and Labour of the Republic of Lithuania 14

15 % GDP Impact of indexation and other measures on the budget of the State Social Insurance Fund. 10,0% 9,0% 8,0% 7,0% 6,0% 5,0% 4,0% 3,0% 2,0% 1,0% 0,0% Costs of social insurance pensions including reform Revenue of social insurance pensions Costs of social insurance pensions excluding reform Source: Ministry of Social Security and Labour of the Republic of Lithuania The labour market reform measures (the new Labour Code and other measures) in the medium term will result in the greater numbers of the employed, and consequently in higher budgetary revenues and more favourable circumstances for pension indexation in the context of sustainable public finances. Social model costs in 2017 Table 7. Impact of the social model on general government finances in 2017 EUR million 2017 I. Revenue 5 A 1 percentage point reduction of social insurance contribution rate -59 Increase in the unemployment contribution rate by 0.5 percentage point 28 Widening of the social insurance contributions base for persons engaged in individual activities 7 Taxation of bonuses by social insurance contributions 6 Employer insurance contribution to the new Long-Term Work Benefit Fund at the rate of 0.5% 23 II. Expenditure 225 Increase in budgetary expenditure due to a 0.5 percentage point increase in the unemployment contribution rate (expenditure increase) 6 Extension of the cases in which sickness allowance is to be paid (expenditure increase) 5 Reduction of budgetary expenditure due to a 1 percentage point reduction of social insurance contributions rate (expenditure reduction) Indexation of pension expenditure (expenditure increase) 167 Insurance of mothers and caregivers from state funds by paying an additional amount up to the minimum monthly wage 16 Raising of unemployment expenditure (expenditure increase) 24 Employee benefits from the Long-Term Work Benefit Fund 18.5 Balance/net costs (I-II) -220 Balance (in % of GDP) -0.5 Source: Ministry of Social Security and Labour of the Republic of Lithuania

16 Tax administration measures in 2017 Tax administration goals in 2017 In the field of tax administration improvement, in 2017 further efforts will be made to reduce the amount of income not registered in official accounting, reduce the value added tax (hereinafter referred to as VAT) collection gap, reduce the incidence of avoidance of taxes and labour related contributions, ensure the justification of personal income and sources of asset acquisition as well as prevent fraud and tax planning (reduction). In 2017 the new measures will mainly focus on better collection of VAT and personal income tax (hereinafter referred to as PIT). Link between tax administration measures implemented and special recommendations of the Council of Europe for Lithuania Tax administration measures serve as means for implementing the recommendation of the Council of Europe for Lithuania (as well as recommendation of 2015): <...> to improve the fulfilment of tax obligations, in particular in the field of VAT. Expected positive impact of new tax administration measures applied on public finances and impact evaluators The State Tax Inspectorate (hereinafter referred to as STI) has evaluated the impact of measures planned for 2017 aimed at ensuring the fulfilment of tax obligations and plans to receive in 2017 additional revenue amounting to 0.4 per cent of GDP. The biggest amount of revenue is expected to be generated in the field of VAT due to the Smart System of Tax Administration that will become operational in the fourth quarter of In addition, legislative provisions that will come into force in 2016 and that oblige financial market participants to submit data on residents accounts to a tax administrator will contribute to better collection of revenue from PIT. Legal status of key new measures and their essence In the field of VAT administration Seimas adopted the Law amending Article 75 and supplementing by Articles 42-2, 42-3 the Law No IX-2112 on Tax Administration of the Republic of Lithuania (19 November 2015). The provisions of the Law require the tax payers as from 1 October 2016 to provide on a regular basis details of VAT invoices and bills of lading of goods transported in the Republic of Lithuania to the Inspectorate. In the field of PIT administration Seimas adopted amendments to Article 55 ( Information provided by supervised financial market participants ) of the Law on Tax Administration of the Republic of Lithuania that came into force on 1 January The amended provisions stipulate that supervised financial market participants are obliged to provide to the Inspectorate not only information on opened and closed individual accounts of all kinds but also information on annual account turnovers, balances at the end of the year, debt obligations, and other information necessary for the performance of the functions of tax administrator. As a result of amendments made to paragraph 1 of Article 104 ( Determination of tax obligation in case a tax payer fails to submit a declaration ) the amount of tax obligation can be determined not only on the basis of data of previous declarations of that particular tax provided by a tax payer but also on the basis of other information received by tax administrator, for example, information provided by third 16

17 parties. Information concerning other amendments to the laws in the field of PIT administration is available on the website of the Inspectorate 4. Measures and assumptions that underlie additional revenue from tax administration in 2017 In the field of VAT administration: 1.1. As from 1 October 2016, VAT payers are obliged to provide data on received and issued VAT invoices and issued bills of lading of goods; the VAT invoice portal (i.saf) and bills of lading portal (i.vaz) have been launched as part of the Smart Tax Administration System. On the basis of the data received cross-checks of VAT invoices that were received and issued by tax payers is performed; the irregularities detected (when buyers enter the invoice into their records, but the seller does not do that and vice versa) will be reported to tax payers, risky transactions with fraud suspects will be identified and control over tax payers will be exercised. As from May 2015 the Inspectorate was implementing the VAT invoice project during the implementation of which at the end of the first half of 2016 approx. 30 thousand VAT payers provided the aforementioned data that made positive impact on the efforts to reduce VAT collection gap, detect fraud and increase additional budget revenue (from January to August of 2016 the declared VAT obligation of tax payers who received instructions increased by 27,9 per cent in comparison to the same period last year). However, taking into account the possibility to perform cross-checks of all VAT payers from 1 October, additional positive influence on budget revenue collection is expected. Additional expectations concerning budget revenue collection are also related to the fact that obligation to inform a tax administrator in advance about the commencement of goods transport by road will significantly limit possibilities for abuse, when after the delivery of goods their transport documents are destroyed in case no checks were performed on the way to destination and revenue from goods realized is not entered into records Aiming to ensure proper supervision of tax payers whose taxes paid have major influence on budget revenue, all tax payers whose taxes paid account for 90 per cent of all taxes paid to budgets and funds have been identified and a constant process involving monitoring, analysis and control of their activity as well as the implementation of a targeted programme on checks of major tax payers and groups of enterprises will be ensured Taking into account cases of abuse detected in the field of supply of bulk petroleum products in 2016, a detailed action plan that includes international cooperation and cooperation with national law enforcement institutions will be implemented In 2017 the budget is expected to receive additional revenue by means of broader control over on-line business and specialised unit at the Inspectorate. In the field of PIT administration: 1.1. Avoidance of labour related taxes when only a certain number of real working hours of a person is entered into records and such person s wage falls below the minimum wage and/or a person receives part of his wage as envelope wage is one of the greatest risks to proper collection of budget revenue from PIT. Aiming to reduce the scope of the abovementioned abuse: control actions will be taken in relation to tax payers who showed no reaction to mitigated measures of influence (warning letters, questionnaires, dialogue) applied in case of payment of wages below the minimum wage to employees;